What Would Happen if Congress Rewrote the Mortgage Interest Deduction?

By :: March 1st, 2011

The deduction for interest on home mortgages may be the most beloved of all tax subsidies. A politician needs only to muse about repealing or restructuring the deduction to be set upon by suburban mobs (led, perhaps, by real estate agents and mortgage lenders).

But a new analysis by my Tax Policy Center colleagues Ridathi Chakravarti and Dan Baneman finds that most taxpayers would barely notice the change in their tax bill even if Congress dramatically restructured the subsidy. And with some changes, many of us would end up paying lower taxes than we do today.

In the unlikely event Congress simply repeals the mortgage deduction, the average tax bill would increase by $710. But those who earn between $30,000 and $40,000 would pay an average of about $70 more while those making more than $1 million would pay an additional $4,000.   

But the deduction isn’t going to be repealed. And if it was, some of the added revenue would surely be used to buy down income tax rates. More likely, Congress will scale back the deduction or replace it with a new design such as a tax credit.  With some of these alternatives, typical middle-income households would likely pay less tax, not more. And many will see no change at all.  

What’s going on?  Mostly, the mortgage deduction is the classic upside-down tax subsidy. It gives the biggest tax breaks to the highest earners who borrow the most money to buy the most expensive houses. Because it is a deduction, someone in the 35 percent tax bracket pays an after-tax cost of only $65 for every $100 they borrow (even less if you figure state taxes). But someone in the 10 percent bracket pays $90—if they itemize.  However, because the deduction is only available to those who do itemize and a surprising number of moderate-income homeowners don’t, many taxpayers get no subsidy at all.          

Let’s look at a couple of reform options. Say Congress caps the mortgage deduction at $500,000 and allows it only for primary residences (today, you can deduct mortgages up to $1 million and use the write-off for second homes).  Since very few middle-income people have $1 million mortgages, you won’t be surprised to learn that almost no households making $100,000 or less would pay higher taxes. Even among those making $100,000 to $200,000, only about 12 percent would pay more. A typical household in this income class would pay about $185 more.

By contrast, about one–quarter of those making $200,000 to $500,000 and 28 percent of those making $500,000 to $1 million would pay higher taxes. If you are pulling in $500,000 to $1 million, (fewer than 1 percent of all taxpayers do) you’d typically pay about $1,900 more in taxes.

What if Congress decided to not only limit the subsidy to $500,000 loans but also turned the deduction into a 20 percent non-refundable credit?  Since the credit benefits moderate-income households and most of them would be unaffected by the cap, the vast majority of taxpayers would be paying roughly the same tax bill as they pay today.  

For instance, those making $50,000 to $75,000 would pay on average $80 less. Only those making more than $100,000 would pay significantly more. Households in the $100,000 to $200,000 range would pay about $650 more on average, although interestingly only half would face any tax hike at all. Those making more than $1 million would pay an extra $2,800 on average. Of course, some would pay much more. 

All of these estimates assume current law where the Bush-era tax cuts expire at the end of next year. But the pattern is the same if you assume the tax cuts are extended. Indeed, typical middle-class households would do even better under the cap and credit if the 2001 and 2003 tax cuts are extended. 

Higher taxes, of course, are only one result of these changes. Homeowners would likely see at least a short-term adjustment in the value of their homes as well. But it is hard to know how much and for how long. And research by TPC’s Ben Harris suggests it would depend a lot on where you lived.  Of course, a cap and credit would probably result in somewhat higher prices for moderate-priced homes but lower prices for mini-mansions. The price of real mansions might not change much at all since the increase in taxes would be trivial for many uber-rich buyers.        

So before you grab a pitchfork at the mere mention of a change in the mortgage deduction, take a look at TPC’s analysis. You may be surprised.

47Comments

  1. Sid F.  ::  7:36 pm on March 1st, 2011:

    Well I would like to take a look at the analyis, but unfortunately the link does not work and I could not find the paper on the main TBC web site. Can you check it for us?

    As far as raising taxes on high income individuals, repeal or modification of the Mortgage Interest Deduction would seem to run into this barrier, as noted by your colleague in an earlier post.

    “Norquist, the Tomás de Torquemada of tax policy, accepts no breach of his “Taxpayer Protection Pledge,” a vow to never raise taxes under any circumstances. According to the ATR website, the pledge has been signed by 237 House members and 41 senators, including Chambliss, Crapo and Coburn. Torquemada, you may recall, burned thousands of non-believers at the stake in the 15th century and was fondly known as “the hammer of heretics.”

    So, leaving aside what would appear to be a political impossibility, what about the Mortgage Interest Deduction. Your observation that it is an upside down deduction, benefiting high income individuals more than low income individuals, is correct, but you know, all deductions without very low limits act in this manner. It is the nature of the beast, by simple mathematics of taxes.

    Also, if a credit is adopted, would this allow homeowner’s who do not itemize and take the standard deduction to have the credit also? If so, does the study address the tax revenue implications of that? This might be ok, since the only tax reforms that will pass this Congress, or ones in the future are one that lower taxes for some people without raising them for anyone. Of course, in that case what exactly is the point?

  2. Secondary Sources: Mortgage Deduction, Crowding Out, Global Imbalances – Real Time Economics – WSJ  ::  9:58 am on March 2nd, 2011:

    […] –Mortgage Interest Deduction: Howard Gleckman points to research looking at the cost of reducing the mortgage interest tax deduction. “The deduction for interest on home mortgages may be the most beloved of all tax subsidies. A politician needs only to muse about repealing or restructuring the deduction to be set upon by suburban mobs (led, perhaps, by real estate agents and mortgage lenders). But a new analysis by my Tax Policy Center colleagues Ridathi Chakravarti and Dan Baneman finds that most taxpayers would barely notice the change in their tax bill even if Congress dramatically restructured the subsidy. And with some changes, many of us would end up paying lower taxes than we do today. In the unlikely event Congress simply repeals the mortgage deduction, the average tax bill would increase by $710. But those who earn between $30,000 and $40,000 would pay an average of about $70 more while those making more than $1 million would pay an additional $4,000. “ […]

  3. sam  ::  4:55 pm on March 2nd, 2011:

    You should reword this statement. As it stands, it is simply inaccurate:

    “Because it is a deduction, someone in the 35 percent tax bracket pays an after-tax cost of only $65 for every $100 they borrow (even less if you figure state taxes).”

    As I’m sure you know, this should read as “someone in the 35 percent tax bracket pays an after-tax cost of only $65 for every $100 in interest paid.”

    Obviously the mortgage /interest/ tax deduction does not subsidize the repayment of principal.

  4. Michael Bindner  ::  9:11 pm on March 2nd, 2011:

    If you scrapped this deducation and the property tax deduction, as well as consolidated other child exemptions and credits, you could for the same funds have a $500 per month per child federal tax credit. Most of that would likely go to housing as many families are substandardly housed for their family size. It would also help people decide to have another kid – which is what we really need to start encouraging to support the aging of the population.

    This would change the mix of available housing – and that is assuming that without the subsidy the rich would buy less house when they go to the beach.

    Not bloody likely.

  5. Around The Dial – March 3  ::  3:11 pm on March 3rd, 2011:

    […] TaxVox imagines changes to the home mortgage deduction. […]

  6. Seth  ::  9:37 am on March 4th, 2011:

    link broken.

  7. Why You Should Never Buy a Home for Tax Reasons | Eileen E Jacobs  ::  12:24 pm on March 23rd, 2011:

    […] Tax Policy Center blog writes, “A new analysis by my Tax Policy Center colleagues Ridathi Chakravarti and […]

  8. Budget Deal: Could the Mortgage Deduction Get Chopped? | Finance Blog  ::  4:29 pm on April 12th, 2011:

    […] everyone from the International Monetary Fund to the Tax Policy Center to the White House fiscal commission have called for the U.S. to cap, redesign or simply get rid of […]

  9. Budget Deal: Could the Mortgage Deduction Get Chopped? – Mortgage  ::  1:53 am on April 15th, 2011:

    […] everyone from the International Monetary Fund to the Tax Policy Center to the White House fiscal commission have called for the U.S. to cap, redesign or simply get rid of […]

  10. Our homes, our tax deductions? | Reuters Wealth  ::  8:27 am on July 13th, 2011:

    […] loan-to-value ratios, and those who fall in higher tax brackets because they have higher incomes. A Brookings-Urban Tax Policy Center study found that the mortgage interest tax break does little to encourage the middle class and less […]

  11. Our homes, our tax deductions?  ::  12:50 pm on July 13th, 2011:

    […] loan-to-value ratios, and those who fall in higher tax brackets because they have higher incomes. A Brookings-Urban Tax Policy Center study found that the mortgage interest tax break does little to encourage the middle class and less […]

  12. What will happen to you if home mortgage tax break ends? | Reuters Money  ::  3:05 pm on July 28th, 2011:

    […] tax deduction does very little to encourage the middle class and less wealthy to buy homes, a Brookings-Urban Tax Policy Center study found. “The largest tax expenditures accrue to those households with the highest incomes as they […]

  13. David Denny  ::  4:18 pm on October 26th, 2011:

    I would like to know how much federal tax revenue will be increased if the proposal to limit the mortgage deduction to mortgages of $500,000 and only to primary residences. I have looked through various discussions and tables but cannot locate that number. David Denny

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